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Exchange Trading Rules

Exchange Trading Rules. Douglas Cumming Schulich School of Business York University, Toronto, Canada Sofia Johan Tilburg Law and Economics Center (TILEC) Tilburg University, The Netherlands. Research Question. Vague versus detailed rules Context: equity stock exchanges

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Exchange Trading Rules

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  1. Exchange Trading Rules Douglas Cumming Schulich School of Business York University, Toronto, Canada Sofia Johan Tilburg Law and Economics Center (TILEC) Tilburg University, The Netherlands

  2. Research Question • Vague versus detailed rules • Context: equity stock exchanges • Do detailed trading rules facilitate trading? • Enhance investor confidence that the risk of manipulation has been mitigated

  3. Prior Work • Aitken and Siow (2003 Hewlett-Packard Handbook of World Stock, Derivative & Commodity Exchanges) • Rank markets based on efficient and integrity • La Porta et al. (2006 Journal of Finance) • Public enforcement of securities laws does little to help the development of stock markets • Private enforcement and disclosure rules help stock markets • Cumming and Johan (2008 American Law and Economics Review) • First look at international differences in surveillance • Cross-market surveillance and information sharing helps development of stock markets

  4. New Contributions • First look at exchange trading rules across countries and time • Relate trading rules to trading velocity • Trading Rules • Insider trading • Market Manipulation • Price Manipulation • Volume Manipulation • Spoofing • False Dissemination • Broker agency conduct

  5. What Are Business Trading Rules? • Found on the stock exchange webpage • Like a contract between all stock exchange trading participants • Some exchanges have vague rules (“thou shalt not manipulate the market”) • Other exchanges precisely set out exactly what they mean by manipulation in the rules…

  6. Insider Trading Rules Frontrunning Client Precedence Trading Ahead of Research Reports Separations of Research and Trading Broker Ownership Limit Restrictions on Affiliation Restrictions on Communications Investment Company Securities Influencing or Rewarding Employees of Others Anti-Intimidation/ Coordination

  7. Market Manipulation Rules Price Manipulation Volume Manipulation Spoofing False Dissemination

  8. Price Manipulation Marking the Open Marking the Close Misleading End of Month/Quarter/Year Trades Intraday Ramping/ Gouging Market Setting Pre-Arranged Trades Domination and Control

  9. Volume Manipulation Churning Wash Trades

  10. Spoofing Giving up Priority Switch Layering of Bids/Asks

  11. False Dissemination Dissemination of False and Misleading Information Parking or Warehousing

  12. Broker Agency Conduct Trade Through Improper Execution Restrictions on Member Use of Exchange Name Restrictions on Sales Materials and Telemarketing Fair Dealing with Customers

  13. New Indices in this PaperAcross Countries and Time • Insider Trading • Market Manipulation • Price Manipulation • Volume Manipulation • Spoofing • False Dissemination • Broker Agency Conflict

  14. Trading Velocity • Accounts for market size… makes different exchanges comparable

  15. Comparison Tests Difference in means and medians Panel A: All countries Panel B: Subset of Mifid Countries Panel C: Pre- versus Post-Mifid

  16. OLS Regressions • Trading Velocity is a function of • Insider Trading Index • Market Manipulation Index • Broker Conflict Index • LLSV (1998, 2006) Indices • GDP per capita (annual lagged) • MSCI Index (monthly lagged) • Robustness • Country dummy variables & fixed effects • Difference-in-differences • Endogeneity considered later

  17. IV Estimates • Rules  Velocity • Velocity  Rules • Use instruments very similar to that in La Porta et al. (2006): • English Legal Origin • Repudiation • Efficiency of the Judiciary

  18. Summary of Key Result • Exchange trading rules a very statistically significant and robust factor • Insider Trading Rules greatest economic significance: • Each rule increases velocity by at least 3% depending on the specification • Market Manipulation Rules also economically significant • Each rule increases velocity by at least 1% depending on the specification • Economic significance is even greater with the IV estimates. • Example: • Euronext Paris (138.57%) versus Hong Kong (95.32%) • Actual difference: 43.25% • Predicted difference for Insider Trading Rules (simple regression): 31.2% • Predicted difference for Market Manipulation Rules (simple regression): 45.18%

  19. Figure 1. Partial Regression Plot of Velocity and Insider Trading Rules Index. This figure presents a partial regression plot of velocity and the Insider Trading Rules Index. The independent variables include the investor protection index (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.152, (robust) t-statistic 2.437 and adjusted R2 is 0.157.

  20. Figure 2. Partial Regression Plot of Velocity and Market Manipulation Trading Rules Index. This figure presents a partial regression plot of velocity and the Market Manipulation Trading Rules Index. The independent variables include the investor protection I ndex (La Porta et al., 2006), the Efficiency of the Judiciary (La Porta et al., 1998), the log of MSCI and the log of GDP per capita. The coefficient is equal to 0.050, (robust) t-statistic 1.812 and adjusted R2 is 0.039.

  21. Conclusions • Insider Trading and Market Manipulation Rules are an important element to encouraging investors to trade on stock exchanges • Detailed rules facilitate trading • Vague rules in countries with high risk of repudiation • Not easy to change business rules, but possible • Mifid rules are an important benefit to trading on European Exchanges

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